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BP Looking to Refocus on Drilling Wells

Will BP’s plans to allocate the vast majority of its capital to its upstream business pay off?

Over the next decade, British oil giant BP(NYSE:BP) plans to direct as much as 75% to 80% of its capital expenditures toward upstream projects, according to Lamar McKay, the company's chief executive of upstream.

BP's decision suggests it has reversed course from its older strategy, which placed a greater emphasis on investing in renewable energy -- as encapsulated by the slogan "Beyond Petroleum" -- and is going back to its roots. Will it pay off?

BP's four main areas of interest BP will be directing its upstream focus mainly toward operations in Angola, Azerbaijan, the North Sea, and the U.S. Gulf of Mexico, where it has more than 40 major upstream projects planned through the end of this decade. Eleven of these are so-called "megaprojects," meaning each will require gross investment in excess of $10 billion.

According to McKay, these four regions combined should generate roughly half of BP's operating income by 2020. Much of the enthusiasm surrounding these projects stems from technological improvements that are allowing for greater quantities of oil and gas to be recovered from fields discovered decades ago.

In the North Sea, for instance, BP's estimate of reserves has gone from an initial 250 million barrels to a number "in the billions," thanks to technology such as 4-D seismic imaging and a new floating vessel designed for production, storage and offloading in harsh conditions. In fact, use of 4-D seismic technology helped the company recover an additional 16 million barrels of oil from its Greater Plutonio projects off the coast of Angola, according to CEO Bob Dudley.

BP's interest in regions like Angola and Azerbaijan highlights how the world's largest Western oil companies are being forced to explore for oil in remote and, in some cases, unstable regions in order to grow production. Yet despite spending heavily on new upstream projects, most have seen production stagnate or decline.

For instance, BP reported that its oil and gas production in the first quarter fell by 5% to 2.33 million b/d of oil equivalent. Similarly, ExxonMobil(NYSE:XOM) reported a 3.5% year-over-year decrease in first-quarter production, while Total(NYSE:TOT) saw a similar 2% decline. In fact, one of the few large integrated oil companies that actually saw modest growth in production was ConocoPhillips(NYSE:COP), which reported a 1.2% increase.

BP going "back to petroleum" Since the 2010 Deepwater Horizon disaster, BP has divested around $38 billion of assets, including half of its upstream facilities, half of its pipelines, and about 30% of its oil and gas wells. And interestingly, despite its earlier push toward renewable energy, the company now appears to be retrenching from green-energy projects in an effort to focus on its more profitable core oil and gas business.

Last month, for instance, it announced that it was looking to sell its U.S. wind-power assets. That revelation followed CEO Bob Dudley's comments about how the company is throwing in the towel on solar energy after decades of failed attempts. BP also seems to have given up on developing carbon capture and storage technology, having scrapped a $500 million Scotland plant in 2007.

Final thoughts Though BP's belt-tightening on green energy could hurt it over the longer term, the company's strategic shift back to petroleum appears necessary, given its current circumstances, and it already appears to be paying off. For instance, its focus on higher-margin oil projects and the $27.5 billion sale of its portion of Russian joint venture TNK-BP helped the company nearly triple its profits in the first quarter.

In the years to come, these new, more profitable oil projects should allow BP to generate stronger operating cash flow. Not only will this allow it to maintain and perhaps grow its sizable 5% dividend yield -- no doubt a major reason some investors have flocked to the company despite the uncertainty surrounding the ongoing Deepwater Horizon litigation -- but it should also help the company gradually improve production and reserves.

Author

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.